Professional advice plays key role for preventing insolvent trading under Australia’s new guidance

The revised guidance was published by the Australian Securities and Investments Commission (ASIC) to help directors and their professional advisers better understand and comply with their duty to prevent insolvent trading, demonstrated through practical examples. It also provides further details on establishing the safe harbour defence against potential claims for insolvent trading, including the formulation and implementation of a “better outcome plan”.

Throughout the guidance, one of the prevailing themes and emphases is the importance of seeking advice from professional advisers, such as qualified lawyers and restructuring practitioners, when developing and implementing better outcome plans for their company and as a prerequisite for directors to apply the safe harbour protection.

Achieving compliance with the duty

According to the guidance, the steps a director should take to comply with their duty will depend on the company's circumstances, including its size, complexity, and the skills and experience of its management and staff. However, there are several key principles that all directors should follow to improve their compliance with the regulatory requirements.

These principles are actively monitoring company solvency, investigating financial difficulties, obtaining professional advice when necessary, and acting promptly if there are reasonable grounds to suspect insolvency.

The updated guidance is simplified to make it easier for directors, particularly those of small-to-medium-sized companies, to understand their responsibilities with practical examples.

Principle: actively monitor company solvency

For directors to stay informed about their company’s financial position, they need to ensure the company maintains proper financial records, prepares relevant financial information, and makes reasonable enquiries to understand the company's financial position and cash flow requirements.

ASIC outlines certain activities directors may need to undertake to meet this requirement. They include:

• overseeing profit and cash-flow budgets, management accounts, and monitoring results;
• regularly reviewing debt collection and asset realisation;
• monitoring creditor payments and compliance with trade terms;
• reviewing bank lending facilities and access to additional funding;
• reviewing tax obligations, lodgment, compliance, and payment of liabilities; and
• periodically reviewing employee entitlements, payroll reports, superannuation, and wages reports.

There are additional requirements when a director relies on internal or external advice for monitoring a company’s financial position. In this situation, it is crucial that management, employees, and external advisers have the necessary knowledge, skills, and experience relative to the business's size and complexity. Directors also need to ensure effective systems are in place to provide them with the information needed to stay informed about the company’s affairs and assess the advice received. As another necessary step to compliance, directors should make appropriate inquiries to remain informed about the company’s financial position and affairs. 

Principle: investigate financial difficulties

When there are reasonable grounds for a director to suspect financial difficulty or potential insolvency, they should not only confirm the company’s financial position and realistically assess options to address financial difficulties, but also ensure systems are in place to evaluate solvency before incurring new debt. It is also important to obtain professional advice if necessary.

Principle: obtain professional advice when necessary

If there are reasonable grounds to suspect financial difficulty, directors should seek appropriate advice on the company's financial position and options to address the difficulties, including the potential for a restructure to continue to trade. ASIC requires that advisers retained by directors must be qualified professionals, such as registered liquidators, lawyers, or accountants. These professionals need to be members of a professional body, hold appropriate insurance, and have relevant insolvency experience. It may be appropriate to engage multiple experts with accounting, legal, financial, and industry-specific knowledge.

Principle: act promptly

If there are reasonable grounds to suspect insolvency, or incurring a debt would lead to insolvency, the director should promptly seek and implement advice.

Safe harbour protection

Directors can seek safe harbour protection from personal liability for insolvent trading, but the availability of this defence depends on two essential requirements. It is available to a director only if, at the time the debt was incurred, the company is paying employee entitlements on time and complying with tax lodgment obligations, subject to some exceptions.

The second criteria states that, at the time the debt was incurred, the director must be taking steps to develop and implement a course of action likely to achieve a better outcome for the company than the immediate appointment of an administrator or liquidator. The second element is usually referred to as the “better outcome plan”.

Documentation also plays an important role for the safe harbour defence to apply. The director’s actions must be adequately documented to provide supporting evidence if needed. Decisions should be based on advice from qualified entities, with the rationale for adopting and implementing the course of action documented.

Under section 588GA(2) of the Corporations Act 2001 (Cth), several factors help determine whether a course of action is reasonably likely to lead to a better outcome for the company. The examples given by the ASIC guidance of what may comprise a ‘course of action’ by the company include:

• conducting an independent business review;
• undertaking capital raising or a debt-for-equity swap;
• compromising or restructuring debt facilities;
• addressing operational issues affecting the company’s financial position;
• implementing cost-saving initiatives;
• ·negotiating or compromising key creditor claims or a restructuring plan with key creditors and stakeholders;
• renegotiating better supplier terms or standstill agreements during refinancing;
• preparing for the appointment of a registered liquidator to implement a company restructure through external administration, if this would achieve a better return for creditors than an immediate appointment;
• if eligible, preparing for the appointment of a small business restructuring practitioner; and/or
• selling the company’s non-core or core business, as appropriate.

The guidance also provides clarification and examples for what is considered as ‘reasonably likely’ when evaluating whether a course of action may lead to a better outcome for the company. For example, it is considered reasonably likely if the course of action is based on relevant and accurate information, developed with sound judgement and is objectively reasonable considering the company’s specific circumstances.

The guidance reminds directors that they should continuously monitor and, if necessary, adjust the course of action to ensure it remains likely to lead to a better outcome for the company. If it no longer meets the ‘reasonably likely’ test, safe harbour protection may cease to apply. Therefore, directors should then consider immediately appointing an external administrator and ceasing to incur new debt.

ASIC guidance on “reasonably likely” in better outcome plan assessment

ASIC’s approach to insolvent trading and safe harbour

The updated guidance also contains the factors and evidence ASIC will consider when assessing whether a director has breached their duty to prevent insolvent trading and when assessing whether a director may establish safe harbour protection. Directors should pay close attention to these factors and the evidentiary matters outlined for each factor in the guidance.

Key factors for assessing insolvent trading include:

• the information available to the director to assess the company's solvency and its accuracy;
• whether the director regularly monitored and inquired into the company's financial affairs;
• whether the director was involved in the company's management when the debt was incurred;
• if the director relied on third-party information about the company's solvency, whether they made diligent and timely inquiries;
• whether there were indicators of potential insolvency that a reasonable person would consider (the indicators of insolvency are listed in the appendix to the guide);
• whether the director took steps to confirm the company's financial position and assess options for addressing financial difficulties;
• whether the director sought advice immediately upon identifying concerns about the company's viability; and
• if the director knew or suspected the company could not meet its debts, whether they took active, timely, and genuine steps to prevent incurring further debt.

Key factors for assessing safe harbour include:

• if the director suspected that the company may be or may become insolvent, whether they developed an alternative course of action reasonably likely to lead to a better outcome than the immediate appointment or an administrator or liquidator;
• whether the director sought advice from a qualified entity, who was provided with sufficient information to offer appropriate advice;
• whether the company's debts were incurred directly or indirectly in connection with the alternative course of action; and
• whether any factors precluding safe harbour protection are present.